Industry and International Analysis PG.1
Assignment Number 3-4
Industry and International Analysis
Chris Hoffman
choffman<at>westminstercollege<dot>edu
801.597.3716
PMBA Program
Jerry Van Os
V1-R3
June 14, 2011
Industry and International Analysis PG 2
Industry
The entertainment software industry is booming, even the recent economic crisis couldn’t
hold it back. In fact the “…industry's real annual growth rate from 2005 to 2009 exceeded 10
percent, which is actually more than seven times the growth rate of the U.S. economy as a
whole.” (Brightman, 2010). Blockbuster video game titles have been smashing movie box office
opening weeks with record breaking sales of their own. In their first week Halo 3 made $300
million, Grand Theft Auto IV made $500 million, Call of Duty: Modern Warfare made $550
million and Call of Duty: Black Ops holds the current record with $650 million. For comparison
in more familiar and reported on figures the following are the highest opening weeks in movie
industry history: The Twilight Saga: New Moon ($140 million), Spider-Man 3 ($151 million),
Batman: The Dark Knight ($158 million) and Avatar ($232 million) (Cantrell, 2011). The
entertainment software industry is truly a force to be reckoned with.
Investors have a difficult time benefiting from the rise of video games because most
publishers are either private or part of a huge company like Microsoft or Sony where video
games only make up a fraction of their business. This paper will look at five publicly traded
companies in the video game industry and try to distil which one is performing the best using a
set of financial metrics.
The Companies
Electronic Arts
The largest game publisher in the world, EA is famous for its licensed sports games like
Madden Football, Tiger Woods Golf and FIFA Soccer. They also publish the some of the
industry’s best selling games like The Sims, Mass Effect, Rock Band, Crysis and Dragon Age.
EA has smaller studios working on niche games like Dead Space, Mirror’s Edge and Brütal
Industry and International Analysis PG 3
Legend. They create games for almost every platform from mobile phones to PC and Mac to X
Box 360 and Playstation 3 with everything in between.
Activision Blizzard
A merger of two big names in the video game industry, Activision Blizzard combines the
world’s best selling console game franchise (Call of Duty) with the world’s number one
subscription-based massively multi-player online role-playing game World of Warcraft.
Activision is also known for the Guitar Hero series, Tony Hawk skating and Transformers.
Blizzard brought the history and quality of such games as Diablo, Warcraft and the de facto
national pastime of South Korea: Starcraft (Ashcraft, 2010).
Take Two Interactive
Long known as the HBO of video games, Take Two Interactive makes adult themed
games that center on plot and character development as well as fast-action. Creators of the Grand
Theft Auto series, the award-winning Red Dead Redemption, L.A Noir and Max Payne have
long pushed the business of video games into becoming the art form it is today.
Konami
The Tokyo-based Konami has been around since 1969 making them the oldest company
of the five on this list. They make games for all platforms including some gambling systems.
Konami has many famous franchises like Metal Gear Solid, Dance Dance Revolution,
Castlevania, Silent Hill and Contra. Konami is also famous in pop culture circles for the
“Konami Code.” Several of their early Nintendo Entertainment System games featured a code
which gave the player more lives and/or ammo. To activate the Konami Code the player had to
enter Up, Up, Down, Down, Left, Right, Left, Right, B, A, Start on their gamepad. Konami also
has a toy division that makes playthings based on their video game characters.
Industry and International Analysis PG 4
THQ Inc.
THQ does a lot of business in the licensing of movies and TV shows and making them
into video games. Hot Wheels, Hello Kitty, Scooby-Doo, Spongebob Squarepants and even the
Sopranos have all been made into games for various systems by THQ. Red Faction and Saint’s
Row have been very popular original properties for them as well.
Company Rankings
The same set of financials were run on these five companies and after a careful
comparison the companies have been ranked from best to worst in the following table:
Best Company
Take Two
Worst Company
Activision
Konami
THQ
EA
1. Take Two Interactive topped this list because in each category it was the second to
worst company in only three measures. The rest of the measures ranked Take Two in
at least third or forth in most categories. This consistency won out over the rest of the
pack who had wide swings between what they did well and what they did not.
2. Activision Blizzard came in second in this list mostly because of poor asset
management and liquidity ratios compared to the industry. Activision had the best
debt management ratios of all the companies but it wasn’t enough to rise above their
above mentioned issues plus mediocre return ratios and performance metrics.
3. Konami did terrible in the asset management ratios and average over the rest of the
metrics never leading in any category. A solid company with two competitors doing
better and two doing worse. Konami would rise quickly with gains in their asset
management.
Industry and International Analysis PG 5
4. THQ starts the race to the bottom. They are masters of asset management and
liquidity, leading in all but one category. THQ falls apart where it counts most:
Profitability and performance metrics. They posted negatives for all profitability and
performance metrics which probably doesn’t help their investors sleep well at night.
5. Electronic Arts rounds out our list in the bottom spot. There doesn’t seem to be much
financially that EA is doing correctly. They were the worst company in almost every
category across the board. Apparently being the 800 pound gorilla in the room does
not equal profits in this case.
Comparative Analysis
Overall Financial Analysis and Performance
Take Two
Take Two’s liquidity ratios are right in the middle of the industry averages. This means
they are neither over nor under leveraged. A happy medium is struck. Take Two could take out
more loans and be a low risk to the bank and they still have some wiggle room if the industry
takes a downturn.
Take Two is also on the high side of average in their asset management ratios. They’re
neck in neck with other firms in getting inventory out the door and cash into their coffers. Their
strengths are fixed asset turnover, total asset turnover and days sales outstanding. Investors can
be confident that Take Two is using purchased property, plant and equipment effectively.
They’re also efficient in turning around product into cash.
Debt management is another area where Take Two is on the high middle of industry
averages. They only fall out of the second spot by fractions in two of the four categories. Take
Two’s debt ratios show that they follow the industry average and are a low risk for default.
Industry and International Analysis PG 6
Profitability is where Take Two really shines. Their return on assets (ROA) and return on
equity (ROA) are tops on this list. Their profit margin is an industry respectable 4.7% twice that
of the average. Take Two’s high ROA & ROE shows investors that they are doing a good job
using assets and their investments to produce revenue.
Finally Take Two’s performance metrics price earnings growth (PEG), internal growth
rate (IGR) and sustainable growth rate (SGR) lead this list of five indicating continued growth
for investors.
The one question mark on Take Two’s record is the over valuation of its stock. Take Two
is a solid player and the best of the five on this list, but they could be in for a hit if they don’t
meet investor’s high expectations.
Electronic Arts
There’s not a lot for EA to be proud of in their financials. Their inventory turnover and
inventory turnover are the only average scores they had. The rest of their ratios are consistently
in the bottom two rankings of the five listed companies.
Especially poor are their profitability and performance metrics. EA’s profit margin is
negative 7.7%, their ROA is -5.7% and their ROE is down to -10.8%. EA’s PEG ratio (-0.48),
IGR (-0.05) and (SGR -0.11) are equally abysmal. These numbers would give any investor pause
and ask themselves, what exactly is EA doing with my money?
WACC
Take Two (WACC 8.9%) Electronic Arts (WACC 8.7%)
Both companies’ WACC are within fractions of each other. In fact after some research
every company on this list and two larger companies (Sony and Microsoft) had WACC ratios
Industry and International Analysis PG 7
from 8.5% to 9%. This seems to be the industry standard. Take Two’s return on net assets cost
them slightly more than EA’s did.
SLEPT
Unemployment
Video games are usually a discretionary income purchase. When workers have less
‘extra’ income video games sales go down. Hardware sales took a hit previously and the trickle
down effect of fewer consoles sold will be less software sold. (Paczkowski, 2009)
Violence stigma
Video games, as well as rock & music and television, have been blamed for a number of
society’s ills. After school shootings in particular it’s common for the media to ask if the alleged
perpetrator played “violent video games.” (Benedetti, 2007) Continued poor attitudes towards
video games could mean lower sales for the industry.
Piracy
Walk around the streets of Manhattan or Shanghai long enough and you’ll see a plethora
of blankets on the sidewalk with all of the latest video games neatly lined up with amazing
prices. Unfortunately the developers never see a dime of those sales. “The Entertainment
Software Association estimates that the video game industry loses about $3.5 billion every year
due to this kind of hard-goods piracy. But these numbers don’t include the 500-pound gorilla:
Internet piracy and peer-to-peer transfers.” (Kalning, 2007) P2P transfers are hard to count as
losses because the users probably wouldn’t have paid for the game in the first place. On the other
hand anti-piracy measures usually hurt and frustrate honest users by inflicting unreasonable
measures to play the game. Some of the measures being: always needing to be connected to the
internet to play or entering your id code every session.
Industry and International Analysis PG 8
Intellectual Property / Copyright
Who owns digital property is still a wide-open question for the court system. In the case
of MDY Industries LLC vs. Blizzard Entertainment attorneys for Blizzard used a novel approach
to copyright infringement to win a verdict. Blizzard produces the massively multiplayer online
game World of Warcraft (WoW). In the game the more a user plays the stronger and more adept
their character becomes. These higher level characters have access to more parts of the game
than lower level characters and it can take months of real-time playing to level high enough for
the game’s premium content. Players who didn’t want to spend the time at their machine leveling
their character could purchase a program from MDY Industries called WoWglider that would
automate a lot of the repetitive tasks required to pass the lower levels. Blizzard sued claiming
that the use of the software was copyright infringement because of the way it manipulated the
game. MDY claimed that it wasn’t infringement because the software only interacted with the
game like a human user would. Blizzard countered that when a user is playing WoW, a copy of
the game is downloaded onto the local machine so manipulating it at a software level was where
the copyright infringement took place. Blizzard won the judgment and it has moved onto
appeals. The implication for the video game industry is: many justices, court officials, lawyers,
politicians and law enforcement officers don’t understand the technology of software and how it
works. This makes it easier for a savvy lawyer of lobbyist to present information that may favor
opponents of the industry.
Gov. Arnold Schwarzenegger v. Entertainment Merchants Association
In 2005, then Governor Arnold Schwarzenegger, signed a bill that made it a crime to sell
“exceptionally violent” video games to minors. The case was recently heard at the Supreme
Court and, as of this writing, is awaiting a verdict. This case has been framed by supporters of
Industry and International Analysis PG 9
the law as necessary to protect children and by detractors as an attack on first-amendment freespeech rights. Lawsuits like these have a chilling effect on the industry as no one wants to be the
publisher that puts out a game which brings down the full force of government down with
expensive new regulations.
Hackers
Hackers around the world are growing bolder and attacking all kinds of technology
companies searching for poorly protected customer data. Sony Playstation Network, the system
that enables online play for all PS3 games, was brought down for weeks while the company
scrambled to plug the security hole (Schreier, 2011). Rockville, MD publisher Bethesda
Softworks, creator of the best-selling Elder Scrolls IV: Oblivion and Fallout 3, was the latest
victim (Pearson, 2011). Hackers got away with usernames and passwords which could lead to
customer’s credit card info. These sorts of attacks are becoming more common, forcing
companies to reassess the security of their networks. This could leave many companies, who
have left this issue at the bottom of their to-do list, vulnerable to data loss or facing expensive
upgrades.
Mobile Phones and Tablets
Platforms other than the console, the bread and butter of game designers, are seeing huge
growth. “A recent report from Deutsche Bank Securities Inc. projected that through 2014,
spending on "social games" on networks like Facebook would grow 46% annually, other online
games 23%, and mobile games 19%. Meanwhile, spending on console-game discs is projected to
drop 6% a year.” (Pham & Fritz, 2011) Consoles need to cater to the new market realities to
remain relevant and developers need to be vigilant about where their audience is, whether it’s on
tablets, consoles or smartphones.
Industry and International Analysis PG 10
Creating Value
Take Two’s numbers show that they have created shareholder value. Conversely, EA’s
numbers show how they’ve lost value for their shareholders. Take Two ran a profit margin of
4.7% while EA has a profit margin of -7.7%.
Take Two also has a solid economic value add (EVA) ratio of 65.24 with EA’s at
negative -166.19. EVA is a commonly used shareholder value metric because it calculates the
between what the street or market value of a company is versus the amount of money investors
have put into the company. In EA’s case they’ve lost investor money to the tune of $166.19 per
dollar earned.
Growth prospects are also clearly in Take Two’s favor. Take Two’s price/earnings ratio
is 24.03 while EA’s is down to -28.53%. As previously mentioned, Take Two enjoys a PEG ratio
of 5.01, an IGR of 0.06 and an SGR 0.09. EA is last in all of those categories (PEG: -0.48, IGR: 0.05, SGR: -0.11)
Financial Market Changes
The gaming industry has been touted as recession-proof by many including the North
America president of Nintendo Reggie Fils-Aime. In 2007 he told CNBC that “…he thought the
sector — and his company in particular — would weather the coming storm. Historically, he
said, video games have done well in tougher economic times.” (Kalning, Is the video game
industry recession proof?, 2008)
The numbers seem to support the assertion. “According to 2008 gaming-related sales
figures from GfK, the gaming industry has shrugged off the global financial crisis and hit sales
results of $1.96 billion with a growth rate of 47 per cent. GfK said that the level of growth
remained steady throughout the year.” (Ramli, 2009)
Industry and International Analysis PG 11
Video game software even seems inflation-proof. A look back at prices for video games
in the early 1990’s shows that when the prices are adjusted for inflation, gamers are playing
more or less the same amount for $60 games than they did then.
Hal Halpin, president of the Entertainment Consumer's Association, said “I think the
bottom line is that it's cumulatively less expensive to be a gamer today than it's ever been.”
Looking at an old Sears catalog for games from 1990 “…put the price of [the original Nintendo
Entertainment System] games around $30 to $50 each. At current prices that's $50 to $80.”
Conclusion
The video game industry has as many things going to it as it has going against it. The
trick is for the industry to stay ahead of the curve because one bad move could be the difference
between beating King Koopa and saving the princess and facing a screen with a gamer’s least
favorite phrase: “GAME OVER.”
Industry and International Analysis PG 12
Bibliography
Ashcraft, B. (2010, July 24). Kotaku. Retrieved June 11, 2011, from Why is Starcraft so
popular in Korea?: http://kotaku.com/5595262/why-is-starcraft-so-popular-in-korea
Benedetti, W. (2007, April 20). Were Video Games to Blame for Massacre? Retrieved
June 13, 2011, from MSNBC:
http://www.msnbc.msn.com/id/18220228/ns/technology_and_science-games/t/were-videogames-blame-massacre/
Brightman, J. (2010, August 10). Video Game Industry Added $5 Billion To U.S.
Economy In 2009. Retrieved June 11, 2011, from Business Insider:
http://www.businessinsider.com/video-game-industry-added-5-billion-to-us-economy-in-20092010-8
Cantrell, M. (2011, June 8). Opening Weekend Video Game Sales vs Movie Sales
Infographic. Retrieved June 11, 2011, from Grab Bag Cinema:
http://www.grabbagcinema.com/news/opening-weekend-video-game-sales-vs-movie-salesinfographic/
Kalning, K. (2007, May 14). Game piracy runs rampant on the Internet. Retrieved June
13, 2011, from MSNBC: http://www.msnbc.msn.com/id/18665162/ns/technology_and_sciencegames/t/game-piracy-runs-rampant-internet/
Kalning, K. (2008, March 07). Is the video game industry recession proof? Retrieved
June 14, 2011, from MSNBC:
http://www.msnbc.msn.com/id/23472166/ns/technology_and_science-games/t/video-gameindustry-recession-proof/
Industry and International Analysis PG 13
Paczkowski, J. (2009, November 13). Video Game Sales Tank. Retrieved June 13, 2011,
from All Things Digital: http://allthingsd.com/20091113/videogame-industry-suffers-massivelymultiplayer-sales-decline/
Pearson, D. (2011, June 13). Bethesda is latest victim of hacking. Retrieved June 14,
2011, from Games Industry.biz: http://www.gamesindustry.biz/articles/2011-06-13-bethesda-islatest-victim-of-hacking
Pham, A., & Fritz, B. (2011, June 05). Video game consoles' dominance is crumbling.
Retrieved June 14, 2011, from Los Angles Times:
http://articles.latimes.com/2011/jun/05/business/la-fi-ct-game-over-20110605
Ramli, D. (2009, February 13). Boost in second-hand games sales upside of global
financial crisis . Retrieved June 14, 2011, from PCWorld:
http://www.pcworld.idg.com.au/article/276261/boost_secondhand_games_sales_upside_global_financial_crisis_/
Schreier, J. (2011, April 26). PlayStation Network Hack Leaves Credit Card Info at Risk.
Retrieved June 14, 2011, from Wired.com: http://www.wired.com/gamelife/2011/04/playstationnetwork-hacked/
Final Comparison
Ratio
Liquidity
Current Ratio
Quick Ratio
ERTS
ATVI
TTWO
KNM
THQI
Average
1.52
1.48
1.85
1.81
2.45
2.35
2.52
2.08
2.95
2.87
1.94
1.88
Current ratio = current assets / current liabilities
Quick ratio = (total current assets - Inventory) / current liabilities
Asset Management
Accounts Receivable Turnover
Days Sales Outstanding
Inventory Turnover
Days' Inventory
Fixed Asset Turnover
Total Asset Turnover
10.71
34.07
46.61
7.83
7.00
0.74
6.95
52.53
39.71
9.19
26.31
0.33
12.29
29.70
46.26
7.89
57.91
1.17
8.79
41.53
11.28
32.35
4.25
0.90
19.45
18.77
64.36
5.67
31.69
1.26
9.98
38.77
44.19
8.30
30.41
0.75
Accounts Receivable Turnover Ratio = sales / Total Accounts Receivabl
Accounts Receivable / (Total credit sales / Number of days)
sales / inventory
365 days / inventory turnover ratio
Net Sales / Net Property, Plan and equipment
sales / assets
Debt Management
Debt Ratio
Debt-to-Equity Ratio
Times Interest Earned (T.I.E.) Ratio
Fixed Charge Coverage Ratio
0.47
0.90
0.00
0.00
0.24
0.31
159.00
198.60
0.37
0.58
5.06
15.73
0.36
0.57
13.34
21.54
0.55
0.59
-1.19
74.75
0.36
0.60
54.69
71.44
Debt / Total Assets
Total Liabilities / Shareholders Equity
EBIT / Interest
EBIT + Deprecation & Amortization / Interest
Profitability
Profit Margin
Return on Assets (ROA)
Return on Equity (ROE)
-7.7%
-5.7%
-10.8%
9.4%
3.1%
4.1%
4.7%
5.5%
8.7%
5.1%
4.6%
7.3%
-1.0%
-1.3%
-2.8%
2.1%
1.0%
0.7%
net profit after tax / sales
Net income / total asstes
Net Income / Shareholder's Equity
Market Value
Price/Earnings Ratio
Cash Flow Ratio
Closing Price
Book Value per Share
Market-to-Book Ratio
-28.53
-0.28
$ 23.86
14.41
1.66
34.41
0.54
$11.77
11.72
1.00
24.03
2.50
$ 16.06
11.21
1.43
19.66
1.98
$ 21.22
21.97
0.97
-31.45
3.61
$ 4.20
10.49
0.40
9.97
0.92
$11.77
12.44
1.36
Stock Price Per Share / Earnings per Share (EPS)
Net Income + Depreciation & Amortization / Average Shares Outstandin
Snapshot stock price
Stockholder Equity - Preferred Stock / Average Outstanding Shares
market value of firm / book value of firm
Performance Metrics
Stock price utilizing the dividend growth model
Economic Value Added (EVA)
-166.19
Market Value Added (MVA)
5516.93
Price-Earnings-Growth (PEG) ratio
-0.48
Internal Growth Rate (IGR)
-0.05
Sustainable Growth Rate (SGR)
-0.11
675.43
3263.82
0.12
0.02
0.03
65.24
776.79
5.01
0.06
0.09
179.47
1071.29
0.54
0.03
0.05
-4.06
-38.57
-0.32
-0.01
-0.03
191.49
3185.85
1.55
0.01
0.00
Net Operating Profit After Taxes (NOPAT) - Capital Charge
Market Value - Invested Capital
(price / Earnings ratio) / Annual EPS Growth x 100
(ROA * Plowback Ratio) / 1 - (ROA * Plowback Ratio)
(ROE * (1 - Dividend Payout Ratio))